Tesco Investor Compensation and Booker Opposition

Tesco (TSCO) have agreed a Deferred Prosecution Agreement with the Serious Fraud Office (SFO) over the overstatement of profits which came to light in 2014. Tesco has also conceded to a finding of market abuse by the Financial Conduct Authority (FCA) in relation to a trading statement issued in August 2014. As a result the company has agreed to establish a compensation scheme for purchasers of Tesco’s ordinary shares or bonds between the 29th August 2014 and 19th September 2014 (inclusive). Compensation will be 24.5p per share plus interest. So any investors in Tesco should check whether they will be eligible.

Note that the overstatement of profits went back several years so this offer may not let Tesco off the hook completely as law suits may still be pursued by disgruntled investors.

The SFO is still pursuing criminal proceedings in relation to individual persons involved in the matter but so far as the company is concerned that seems to conclude the matter as regards regulatory legal action. Tesco will take an exceptional charge of £235m for the compensation and other associated costs (that’s more than the profits they declared last year but only a small fraction of what they used to report annually).

The Financial Times reported this morning that there is opposition from major shareholders Schroders and Artisan to the proposed takeover of Booker by Tesco. Together they hold more than 9% of the company’s shares and Schroders have written to the Chairman urging him to withdraw the bid. Apparently the high price being paid for Booker is the concern.

Comment: the prospective p/e of 25 for Booker certainly makes it look a high price for what is basically a low margin food wholesaler even if Booker has grown profits rapidly in the last few years. There are also clear synergies between the businesses that can be exploited by Tesco. So this is not a clear cut matter it seems. If any readers have any views on it, please add your comments.

Roger Lawson

Pay Revolts and Rolls-Royce Voting Recommendations

According to a number of press reports we seem to be heading into the AGM season with another year of pay revolts. There are also rumours that Mrs May is to proceed with introducing annual pay votes.

Chris Cummings, CEO of the Investment Association, writing for the Guardian said “Too many people still feel they are not sharing this country’s prosperity. Companies can either act responsibly now and shape a more responsible 21st-century corporate Britain or they can carry on as before and have it foisted upon them”. Well said Mr Cummings.

Rolls-Royce looks like it will be one of the early battles. My wife has a nominal holding so I will probably go to the AGM on the 4th May as I have in previous years. I seem to have been writing a lot on Rolls-Royce in the last few years simply because of the amount of news, mostly bad, coming out of the company – profit warnings, bribery, imprudent accounting, new CEO and more.

The latest controversy is that CEO Warren East was paid a bonus of £960,000 last year even though underlying profits fell very substantially. It’s the usual story at Rolls-Royce – orders up but profits down (underlying profits down from £1,432m to £813m. Mr East clearly has not yet managed to sort out the company, and certainly not as quickly as hoped for when he joined. Other financial numbers are also poor – free cash flow down, debt doubled, and dividends to shareholders substantially reduced.

Mr East still managed to achieve 55% of his maximum bonus by reaching some of the profit and cash targets, although trying to understand the 22 page Remuneration Report to see how this was achieved is not at all easy. But in summary Mr East achieved total pay of £2.1 million (“single figure of remuneration”) in 2016. That compares with £543,000 in 2015 but he only served for part of that year.

Two other executive directors (both named Smith) achieved £1.3 million and £1.2 million, both up substantially. At least the Chairman did not get any more but he still collected £425,000 in salary.

Oliver Parry of the Institute of Directors said in the Guardian that “The idea that the CEO is receiving a bonus after two profit warnings doesn’t sit very well with investors”.

Needless to point out that the share price of Rolls-Royce remains in the doldrums and has only risen somewhat from its low point in February 2016. So how is this pay scheme aligning directors interests with those of shareholders? It is not apparent.

This year shareholders get to vote on both the Remuneration Report and the Remuneration Policy. In addition there is a vote on the Long-Term Incentive Plan (LTIP). But it’s the same kind of remuneration scheme that pays out enormous amounts as we see in lots of large public companies. For example under the proposed policy, Mr East can achieve a maximum of £5.1 million and the CFO £3.4 million.

ShareSoc’s recommendation is to vote against the Remuneration Report, the Remuneration Policy, the LTIP, and against the reappointment of Ruth Cairnie (Chairman of the Remuneration Committee). We also suggest voting against Chairman Ian Davis who must surely take some of the responsibility for these arrangements.

Is this not a company that would benefit from a Shareholder Committee? Clearly they need more input from stakeholders when making decisions on remuneration before they get put to a vote at the AGM.

The AGM of Rolls-Royce will be held in Derby near one of their main operating bases. But employees will be able to attend a separate “annual general meeting” for employees so as to strengthen links with them. Or is this a way of avoiding them attending the same AGM as shareholders and hearing the concerns expressed about pay?

Roger Lawson

Fundsmith Annual Shareholders’ Meeting – An ODD investment strategy

The Annual Shareholder Meeting for holders of the Fundsmith Equity Fund was held last night (20/3/2017). Here’s a brief summary of manager Terry Smith’s presentation and the question/answer session (summarised or paraphrased for brevity). You should be able to watch the whole 2 hour proceedings on the Fundsmith web site soon.

He noted that there was not much happening since last year (Terry prides himself on investment inactivity). The Fund was up 28.2% last year which was similar to the MSCI World Index. It’s the first year they haven’t outperformed the market, but it’s a bullish market at present when the Fund’s holdings are quite defensive.

Terry spelled out his “ODD” investment strategy:

– Only invest in good companies.

– Don’t overpay.

– Do nothing.

He emphasised the good “metrics” of the holdings within the fund: ROCE, Gross Margin, Operating Margin, Cash Conversion, Leverage and Interest Cover, versus the market. For example, free cash flow of the holdings grew 11% when earnings of companies in the index grew zero last year. He discounted allegations that they were too focussed on consumer staples – those holdings have actually been a drag on the fund’s performance in the last few years.

Portfolio turnover was only 0.5% last year (it had actually been negative in previous years because of the way it is calculated).

We then moved to questions/answers (only written questions taken due to the number). I’ll highlight just a few of the more interesting ones:

Question: On actual fees charged to the fund (based on newspaper reports). Answer: the management charge is unchanged. Ongoing charge of 1.16%. The newish office in Mauritius was mentioned and Terry has moved there – he has had a home there since 2014. This is partly to manage the FEET portfolio. Terry emphasised he has not retired, and he does not play golf. Comment: appears to be another workaholic.

Question: Have the portfolio changes had a negative or positive impact? Answer: it’s difficult to do that analysis, but it’s probably made things better. Similar question was on Dominos Pizza – holding sold when it then outperformed. Answer: sold because free cash flow yield fell to 2.7% (was 11.6% when invested). Terry admitted he could not be right all the time.

Question: The Fund doubled in size last year. Will it be closed to new investment? Answer: In summary not at the moment . Could double size of fund without a problem in terms of liquidity in the holdings. For example Microsoft holding is one tenth of 1% of shares. Closing a fund is also not easy.

Question on FEET (Fundsmith’s Far East investment trust): Why has Terry only invested £5m in it (he has hundreds in the main fund)? Answer: the problem is that FEET is illiquid, and he already proportionally has a bigger holding in it. Terry also discussed the large flows into index tracking funds in Far East securities which now dominate the sector and were distorting the valuations of the large cap companies they hold. He said the “dream of an active fund manager is to be the last active fund manager in the world”.

Summary: as usual this was an entertaining and educational evening. You can learn a lot about the investment strategies he uses to achieve such great performance, which are probably just as applicable to smaller UK companies as they are the large global companies that make up the Fund’s portfolio on the whole. Anyone who did not achieve 28% return on their own portfolio last year should certainly study Terry Smith’s activities in detail.

There is a longer report on the meeting on the ShareSoc Members Network.

Roger Lawson


Share issues – And An Interesting Rule

Spring is in the air, and companies are clearly in a mood to raise cash. A lot of these have been share placings but the reasons given have been varied. Placings rather than rights issues are always prejudicial to private shareholders as they are generally unable to participate, unless an “open offer” is included.

The share placing at IDOX (IDOX) was covered in the January issue of the ShareSoc Informer Newsletter and there is now a report on the AGM of that company on the Members Network where shareholders raised the issue again.

Cello Group (CLL) undertook a placing to fund the acquisition of Defined Healthcare – they raised £15 million to do so, but the placing share price was at a small premium to the previous market price. although the price moved up significantly after the placing was announced.

Learning Technology Group (LTG) did a placing to finance the acquisition of NetDimensions.

TrakM8 (TRAK) raised £1.66 million through a placing at 65p so as to reduce the company’s bank debt and strengthen its balance sheet. This was at a significant discount of 17% to the previous market price. The directors of the company took up a large number of the shares on offer.

One company that is doing a full rights issue is property business Segro (SGRO) although they had done a placing recently. The new transaction is to raise £573 million to finance the acquisition of the balance of an interest in Airport Property Partnership they did not already hold. However, the rights issue is being done at a discount of 28.9% to the previous closing price. Although investors can sell the “rights”, if they don’t and otherwise do not take them up then they will be diluted. Investors in Royal Bank of Scotland will not have happy memories of their heavily discounted rights issue in 2008.

One interesting recent announcement was from South African gold mining company Pan African Resources (PAF). They have apparently been “book building” to finance the development of a new gold mine at Elikhulu. But the Johannesburg Stock Exchange (JSE), where PAF is dual listed, has a rule that a company cannot issue shares at a price that is in excess of a 10% discount to the 30 day volume weighted average price. But as the current share price is lower, they have decided not to undertake an equity issue at this time and will finance development in other ways for the time being.

Now would that not be a good rule to adopt in the UK? It might make shareholders a lot happier because there are grumblings about all the above.

Roger Lawson

Employee Directors at Sports Direct

It seems that controversial company Sports Direct (SPD) are likely to become the first UK public company to have a worker on their board. They plan to appoint an elected “Worker’s Representative” who will attend and speak at board meetings although they would not formally be appointed as a director. A spokesman for Sports Direct said: “Having explored all options we believe this is the best way to ensure the Workers’ Representative is free to champion the interests of all staff. We see this as a major step forward in bringing about positive change.”

Comment: if that improves their employee relations, which has seemed far from ideal in the past, then so much the better. But is there not a risk that the person so appointed might be seen as a “shadow director”? For those not familiar with that concept, anyone who has significant influence on the operations of a company and its board could be seen as a shadow director and in that case the legal position is that they have the same duties and obligations as any other director (and the associated legal liability).

One objection to these kinds of arrangement is that employee directors might have power without the associated obligations and hence make cavalier decisions. But in this example, not being formal directors they presumably will not be able to vote on any board resolutions.

ShareSoc has not adopted any formal policy on employee directors although we do think that a Shareholder Committee is a better way to improve corporate governance and stakeholder engagement. The presence of a worker representative on a Shareholder Committee might be an alternative solution.

Roger Lawson

NCC Group – Rob Cotton Departing

In a previous blog post I commented that bearing in mind past events, I doubted that many investors would continue to believe that the long-standing CEO Rob Cotton should continue to lead the company. It would appear the directors agree with me because this morning (1/3/2017) it was announced he was stepping down with immediate effect. Brian Tenner, CFO, will take over as interim CEO and will lead the previously announced strategic review.

The share price rose slightly in early trading on the day. Does this mean that NCC is now out of the woods and shareholders can relax? Or those who sold after the several recent profit warnings should buy it back? As an existing (if now albeit small) shareholder in the company I would not want to give any advice on that of course (ShareSoc and its directors never give buy or sell recommendations as we keep on advising folks but some people seem to forget). All I can say is that in these kinds of circumstances, there is often more bad news revealed over time as new management tackles the past problems and it can often take many months to get clarity on the future prospects for the business. But one thing to always look at when a company is in some difficulties is the strength of the balance sheet.

Roger Lawson

Alliance Trust Vote – A Victory for Private Investors and ShareSoc

Today Alliance Trust shareholders voted to support the Board’s proposals to change the investment management arrangements and to buy out Elliot. This is surely a major win for private investors and for the stance taken by ShareSoc and the Alliance Trust Shareholder Action Group (ATSAG) which ShareSoc has supported over the last 3 years. ShareSoc wholeheartedly backed the Board’s proposals. Alliance Trust can now move forward.

But it was a close run thing as proxy advisory services who advise institutions were not happy with the buy-back. As a result only some 77% and 83% of votes were cast for the relevant resolutions and the second one required a 75% vote as it was a special resolution.

See the ShareSoc Alliance Trust campaign page for more information and a report on the Meeting: http://www.sharesoc.org/alliance.html

Roger Lawson